China Milk-Powder Investigation Risks Turning Sour

The antitrust bureau of China’s National Development and Reform Commission has launched an investigation of three major foreign baby-formula brands—Mead Johnson Nutrition Danone, and Nestlé—for price fixing.

The NDRC is citing Article 14 of the Anti-Monopoly Law as grounds for the investigation, suggesting that it sees the three companies, the largest foreign makers of milk powder by market share, of abusing their commanding market position to set unfairly high prices. The law has been used to go after companies for setting high prices before; in early January Samsung, LG, and a number of Taiwanese television makers were fined $22 million and ordered to pay consumers $27 million for fixing prices of flat-panel TVs.

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A Beijing supermarket’s milk-powder aisle.

But are price fixing and unfair competition the real issue? There are three key issues that the government needs to go after.

First, there is the issue of keeping prices under control across the board, not just for foreign brands. The government is worried about rising prices for all products, and within milk powder specifically this is a key concern. Overall milk-powder prices are up 30% since the melamine scandal in 2008, and prices of imported milk powder are up 60%—and can cost twice as much as the same brands sold in Hong Kong or markets overseas. The government needs to ensure that Chinese babies have access to safe, high-quality milk powder at an affordable price, and is using the investigation to ensure that prices do not continue to go out of control.

It’s not that Nestlé, Danone and Mead Johnson are colluding to fix prices per se. But a key issue is that the prices of the top brands affect other companies’ prices. No Chinese company wants to be seen as too cheap, since safety-conscious Chinese consumers still closely associate low price with poor quality and safety. So when any company raises its prices, the others follow suit to avoid becoming the cheap, low-end—and therefore unsafe—option.

Despite the high prices, demand for foreign milk power keeps surging. In interviews that my firm, the China Market Research Group, has conducted with thousands of Chinese mothers over the past two years, we’ve found that product safety is overwhelmingly their top concern when shopping for their families. The vast majority of mothers of infants and toddlers are willing to pay a high premium to buy imported milk powder—or actually buy it overseas, to minimize the risk of getting a counterfeit—to ensure that it won’t harm their babies.

It’s typical of Chinese consumers to associate high prices with quality and safety, and vice versa. Prices are no longer numbers in themselves, but a reference for the quality standard. For foreign producers of baby formula, differentiated pricing is simply a strategy that helps them establish their ground in Chinese market, and is justified by strong consumer demand.

Differentials in pricing for premium foreign brands between China and other markets are actually pretty common, and not just in milk powder, diapers, skin cream and other products associated with children or safety concerns. A 16GB iPhone 5, for example, costs 23% more in Mainland China than in the U.S. Consumers have many cheaper smartphone options, both from foreign brands like Samsung (though its Galaxy Note costs 30% more in China than in the U.S.) and domestic brands like Xiaomi and Coolpad, but many are still willing to pay a higher price for an iPhone.

Second, the government needs to focus more on improving quality control and testing, not just within the dairy sector but for food production overall. Five years after the melamine scandals, there’s little sign the government has regained Chinese consumers’ trust in its ability to deal effectively with food and quality issues, and continued failure in this area presents a serious long-term risk for social stability. Addressing food-production standards also goes beyond restoring confidence in domestic brands and the issue of corporate corruption; it also ties in with water and soil contamination and overall environmental pollution. Pollution and the environment are a key issue that needs to be dealt with even more than corporate corruption—the Chinese public is increasingly fed up with the situation and is demanding solutions.

Third, the government needs to make sure that it does not target foreign companies only, or target them unduly for corrupt practices while neglecting malfeasance by domestic companies. That would be playing to a fear already common among foreign multinationals: that the government unfairly protects Chinese companies and gives them more leeway than foreign competitors. It would also risk sending an unintentional message to domestic companies that they are off the hook when it comes to quality control, safety, and corruption issues. And that’s no way to restore the public’s confidence.

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